Altria Group Inc. (MO, Financial) is probably the best investment in the world. Aside from any ethical concerns about the company’s business of manufacturing and selling cigarettes, it has produced the best returns for investors during its history than any other public company. This may be hard to believe, but it is true. Between 1968 and 2014, shares in Altria produced a compound annual growth rate of 10.8% (or 20.6% if you include dividends not reinvested). These returns exclude any benefit shareholders would have received from the spinoff of Philip Morris (PM, Financial) and other companies over the years.
Altria even leaves Warren Buffett (Trades, Portfolio)’s conglomerate Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) trailing in the dust. Between the beginning of the third quarter of 1996 and today, Berkshire Hathaway has produced a CAGR of 9.9% for its investors, turning $10,000 into $70,767. Over the same period with dividends invested, Altria has produced a CAGR of 17.92%, turning $10,000 into $304,733. Once again, these figures do not include any contributions from other spinoffs.
The company continues to produce returns for investors. Shares in Altria have returned 21.7% over the past 12 months and yielded $2.44 in dividends.
The big question is, will the company continue to produce these returns? Headwinds are building against the company with cigarette sales declining and its valuation at nosebleed levels. Indeed, at the time of writing, Altria's shares trade at a forward price-earnings (P/E) ratio of 21.3, a price-book (P/B) ratio of 47 and an EV/EBITDA ratio of 18.4. Altria’s net profit has grown at a steady 6.1% CAGR for the past six years and earnings per share increased at 7.4%. Book value per share has declined at a steady 10% since 2011. For full-year 2017, Wall Street analysts expect Altria to report EPS of $3.33. The shares support a dividend yield of 3.7%.
Does it deserve the valuation?
It can be argued that Altria deserves its current valuation. The company has an operating margin of 30% and return on capital employed has risen from 20% in 2010 to 32% at the end of 2015 (return on equity is meaningless here because the company has a net gearing level of 393%). Free cash flow per share came in at $2.85 for 2015 and is likely to be above $3.10 this year, indicating a free cash flow yield of 4.4%. This valuation seems about right considering the current interest rate environment and the bond proxy nature of Altria’s shares.
One of the really fascinating traits of the cigarette business is the ability for cigarette companies to increase prices steadily without any significant impact on sales. Cigarette sales are generally declining as consumers move away from the cancer-causing products. To offset these sales declines, companies are steadily increasing prices. As a result, businesses like Altria are seeing wider margins and higher returns on capital invested -- this is why the company has been able to grow net profit at a steady rate of 6.1% per annum over the past few years while sales have increased at a rate of only 0.9% per annum.
High valuation is justifiable
As Altria becomes more efficient, a higher valuation is more justifiable. Altria’s forward P/E has risen over the past five years from an average of 13 for 2011 to 25 today. Over the same period, the company’s return on capital has increased by a third and free cash flow per share is up by nearly 150%. Even if these trends do not continue, Altria’s steady 7% per annum earnings growth will justify a higher share price in the long term. Management has also committed to increasing the company’s dividend payout by around 10% per annum.
All in all, it looks as if shares in Altria do have scope to move higher from their current levels despite worries about valuation and sales declines. While the returns may be lower than the 17% per annum experienced during the past two decades, Altria looks as if it still has what it takes to extend its record as the world’s best-performing investment.
Disclosure: The author owns no share mentioned.
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